Big Central Bank Mystery will set the tone for TL assets

Despite Turkey’s alleged foreign policy adventures and soaring Covid-19 patient figures at home, TL assets are on a tear. Closing at 1,210 points Borsa Istanbul’s main equity index broke an 8 month record, while dollar/TL declined to 7.86, when the previous week many investors called for a “8 handle”.   Are Turkey’s fortunes improving? Is there  story to invest in?


Turkey’s alleged foreign policy adventures ought to be a non-issue for financial investors, except the test firing of S-400s, which might elicit CAATSA sanctions if Joe Biden is elected president. However, I believe Biden will first invite President Erdogan to mothball them and re-join the US-NATO alliance as a dues paying member, rather than flirting with Russia before he unleashes CAATSA on Turkey.   Unlike many analysts I don’t think Erdogan is committed to activating S-400s at the expense of a devastating blow to his economy. Azeri-Armenian clashes, Cyprus and East Med tensions are largely magazine topics which create noise in the channel, but have little to no impact on Turkish economy or voter behavior.


That being said, Turkey doesn’t have a story. The Erdogan administration has no concrete plan to combat the raging Covid outbreak or to restore growth to the economy. Erdogan is preoccupied with Islamization and natural gas discoveries.  The failure of Turkey Wealth Fund to raise funds through a Euro-bond issue suggests that fixed income managers remain skeptical about Turkey’s state finances, too.


So, what is new?  Well, while Erdogan is yet to decide on a more market- and Western-friendly policy course, he might have allowed Central Bank of Turkey (CBRT) to manage monetary policy rather than second-guessing it at each step.


As of Tuesday, the average interest rate on OMO lending rose to 12.40%, much higher than the official policy rate of 10.25%.  If CBRT follows up on tightening with another 150-200 basis point hike in Thursday’s Monetary Policy Committee, it just might suffice to lure some carry trade and macro-strategy funds into TL assets, reversing its FX reserve drain and stabilizing the exchange rate.  But, will it.  ING bets on 150 basis point rate hike.  JP Morgan just issued a report predicting 200 basis points.


The research experts wrote:


We expect the CBRT to hike its policy rate by 200bp and keep the cautious rhetoric on Thursday. The 200bp rate hike delivered by the CBRT in September was a blunt step taken in the right direction to contain risks to price and financial stability. But these risks are still in place and given the erosion in credibility and sentiment (as reflected in the ongoing worsening in inflation expectations, portfolio outflows, and local demand for gold), there is a need for higher rates. The current level of real interest rates appears low (in both ex-post and ex-ante terms) in a historical context.

We believe Turkey needs to offer a real positive interest rate of at least 2-3% (and stick to free market practices) in a sustained way to restore credibility, to stop dollarization and to attract some capital inflows. If inflation remains stable at 11%-13% as we project, the EFR will need to rise at least to 13%-15%. A policy rate hike of 200bp, which would bring the policy rate to 12.25% and the upper band to 15.25%, would be a reasonable step in our view. We were expecting this hike to be delivered in two instalments but seeing the persisting pressure on the lira, the CBRT will likely deliver all of it at once next week.

Depending on market reaction, there is the risk that further tightening is needed in the coming months.

Monetary policy works through rate changes, as well as signaling. If CBRT were to take the “bold step”  described by JP Morgan, the signal will be loud and clear:  We are free of Erdogan’s tutelage, and will whatever it takes to defend the TL.

If such a signal is given, it could also benefit the Borsa Istanbul, contrary to well-known negative correlation between rates and equity prices, because the index is heavily weighted towards companies carrying large FX debts and banks.  The latter would  see the erosion in its FX-based capital adequacy measures stop, as well as face syndicated loan managers with a stronger argument.

Of course, there will be a price to pay for higher rates, which renders me extremely cautious about Erdogan’s intentions.  Positive real rates might stop dollarization and currency depreciation, but they’ll also eventually kill the loan demand, dooming Turkey to a winter recession. With his approval softening and his party   dropping in the polls, will Erdogan dare risk a recession?

Does he understand that stopping monetary tightening will trigger both a recession and a potential BoP crisis?

I’d personally bet on no or a small change in official policy rate, but wide bands for Late Liquidity Lending rate for Erdogan to have his cake and eat it, too.


Atilla Yesilada


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Published By: Atilla Yeşilada

GlobalSource Partners’ Turkey Country Analyst Atilla Yesilada is the country’s leading political analyst and commentator. He is known throughout the finance and political science world for his thorough and outspoken coverage of Turkey’s political and financial developments. In addition to his extensive writing schedule, he is often called upon to provide his political expertise on major radio and television channels. Based in Istanbul, Atilla is co-founder of the information platform Istanbul Analytics and is one of GlobalSource’s local partners in Turkey. In addition to his consulting work and speaking engagements throughout the US, Europe and the Middle East, he writes regular columns for Turkey’s leading financial websites VATAN and and has contributed to the financial daily Referans and the liberal daily Radikal.